Apple: Wells Sees Five ‘Phases’ to $564B More in Market Cap

By Tiernan Ray

Wells Fargo’s Maynard Um today reiterated a Market Perform rating on shares of Apple (AAPL), and a “valuation range” of $505 to $575, arguing that there is “long-term opportunity” in the stock, but that the company will first have to contend with potential erosion of its gross margin, and problems growing sufficiently given its $467 billion market cap.

But the main points of the 27-page paper issued to clients are actually a more extensive thesis about what Um sees as the five “phases” of a “secular story” for the company, one with many opportunities, and some risks.

He outlines those five phases in a graphic (click for larger image):

Maynard Um of Wells Fargo outlines multiple phases of what he sees as a “secular story” for Apple.

“The end goal, in our opinion, will be the collection, utilization, and, ultimately, monetization of granular end user data. However, we believe this will be broken up into further phases,” writes Um.

Apple’s already successfully gone through phase one, as he sees it, creation of an “ecosystem,” which Apple has done with its iOS software and iPhone and iPad: “Apple has, in our opinion, created one of the leading ecosystems in the industry (along with Google), and we believe new entrants to the market will find it difficult to compete (though we acknowledge mini-ecosystems will likely continue to sprout).”

In phase two, he’s worried Apple doesn’t seem to be on the right path to capture the low-price smartphone markets in Asia, based on who it’s hiring, he opines:

We believe emerging markets are a large part of the remaining markets, which today are being driven by lower priced smartphones (we believe this is one reason why Apple’s market share in smartphones decreased to 15% in 2013 from 19% in 2012). Apple’s hires of former CEO of Burberry, Angela Ahrendts, as head of Retail and the former CEO of Yves Saint Laurent, Paul Deneve, to work on “special projects” for CEO Tim Cook reflect, to us, a mindset toward high-end luxury goods with healthier margin, rather than lower end commodities. While we fully anticipate Apple to address emerging markets, we question whether it can find material penetration near to medium term in a market that appears to be more sensitive to price.

Apple is meanwhile entering phase three, trying to “leverage” its “distribution channel,” initially with things such as giving away its iWork productivity software, later with new devices such as smart watches: “We believe the information collected by iDevices (like an eventual iWatch) will be for the purpose of knowing more about the habits and status of the end user. While monetization, for a public company, would be the next logical step, we believe the next phase will not be about monetization…yet.”

He thinks in coming years Apple will enter phase four of the secular development, where it uses Big Data to sort and sift what it knows about customers:

Apple’s mantra, in not so many words, is about creating great products that have great utility to people. Hence, we believe Apple will use collected information to bring more utility to end users’ lives by predictively delivering content and services, i.e., machine learning, or artificial intelligence. By combining data points such as age, gender, location, calendar information, behavioral history, or even data mined from e-mails, like travel itineraries (and much more), Apple could effectively become a more proactive personal assistant. Hence, the ultimate goal of this phase will likely be to offer a value-add service to not only simplify, but also improve the consumer experience. While Google Now has, in our opinion, an early lead, we believe Apple’s CarPlay announcement hinted at an upcoming similar service.

Phase four likely involves a bunch of artificial-intelligence style applications, such as the following:

For example, if a business client e-mails a user indicating he or she is looking forward to his or her lunch meeting and the address is embedded into the e-mail, Apple can send the user an alert to leave early because there is traffic along the route and that there is a restaurant along the way that the client frequents in order to pick up lunch on the way. The system can also set route guidance when the user enters the car.

Lastly, in the fifth phase, Um thinks Apple may find novel ways to charge money for the combination of smart devices and knowing about customers:

More radical change to the model, in our opinion, could involve allowing users to permission apps to access their data, which Apple could potentially charge for. For example, a user can allow a healthcare provider access to iWatch health and exercise data directly in-app to get lower premiums. In this model, we note that the distribution of “ads” (or really, value) is driven by the distribution of apps. Hence, Apple’s ecosystem provides a powerful distribution platform for companies that may be looking to use their own apps to drive targeted marketing opportunities. What we highlight is that much of what Apple is doing is being done “in-app,” even payments (look at the Apple Store app, which obviates the need for NFC). We believe its iBeacon and mobile payment strategies may also heavily revolve around an “in-app” strategy, which is, effectively, a strategy strictly in and around its iOS devices.

The upshot of all this could be add a lot of money to Apple’s market cap:

If Apple is eventually able to shift its business model, we believe it could add additional market-cap opportunity. Adding the market caps of Google, Yahoo!, and Facebook would add an incremental $564 billion in market cap. While there is opportunity, we believe the transition of Apple’s business model could be lumpy.

Um is rather short on describing the risks for Apple, but he does believe there is a real danger that power in smartphones is going to shift back to the telcos, which in turn could crimp subsidies for devices, and hurt margins:

While history might suggest that each “s” cycle and the resulting gross margin expansion would lend itself to a more positive story for Apple, what complicates the product-cyclical story, in our opinion, aside from the extremely limited visibility at this point in time, is our view of the potential balance-of-power shift between the operators and the handset vendors.

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There are 8 comments

APRIL 11, 2014 4:10 P.M.

Brian Nesmith wrote:

This reads like a "secular strategy" for getting out of the hardware business.

APRIL 11, 2014 4:28 P.M.

Hu Flung Dung wrote:

Maynard Um should have sent his graphic to the Apple brass six years ago. Now, it is really a cruel joke, knowing full well that Apple simply flushed away its market share down the toilet.

So wave goodbye to Phase-2, since Apple lost that battle was without a fight, and in fact, handed it over to Google in a nice gift wrap. A company with a death wish could not have done any worse.

Without the platform of Phase-2 to stand on, wave goodbye to Phases 3, 4 and 5, too. Those things are all happening or will happen in the Android ecosystem.

In the meantime, Mr. Tim Cook continues to think any iPhone below $500 is "junk", and Apple knows what customers want before even they do, and Mr. Phil Schiller continues to think the ad agency is to blame for customers buying a mind boggling 500+ million smart phones because either they had 5" or bigger screens, or were more rationally priced than iPhones, even as at least one employee within Apple was going around showing a slide titled "Consumers want what we don't have".

I suspect by this time next year, we shall see an updated slide from Maynard Um that shows "Multitude of blunders" as the current phase that started in 2010, and perhaps ending in early 2015, and two new phases titled "New leadership" and "Restructuring".

APRIL 11, 2014 4:33 P.M.

Anonymous wrote:

this is almost like Apple Investor Relations gets free advertising. How kind of you, Barrons.

APRIL 11, 2014 5:33 P.M.

Peter Gittlin wrote:

Dung is correct - Cook and current management allowed Android to take over the market they created. How could every other manufacturer come out with a 5 inch Smartphone and yet we are still waiting for Apple to deliver this no brainer product. The 5c model was complete stupidity in it's pricing and size. If priced at $399. it could have at least semi-competed in emerging markets. Apple was way to slow to add carriers and asked for too high sales commitments which allowed Samsung to grow sales and market share enormously. Also Cook wasted so much money in buy backs when he could have acquired so many great companies and great management such as NFLX,TSLA, Nest, Instagram, Twitter, Pandora the list goes on and on. At least investors would see revenue growth and Apple branching out to where the growth is. The problem with Apple is Cook keeps saying we only want to do a few things well at Apple. Well if every other company is making good enough Smartphones, Tablets and Computers than there is not much room for growth.

APRIL 11, 2014 6:37 P.M.

TruthSeeker wrote:

Pathetic! This ridiculous analysis is nothing short of Pathetic, and Mr. Ray never gets tired of publishing B.S. stories from analysts trying to rescue their testicles from the Android and Windows vise. Apple has nowhere to go, and will never escape the gulag they have put themselves in. How many years of proof do we hav to have to stop this B.S.? Notice how apple's stock keeps going down when dummies like Mr. Um and others keep praying on their knees for it to go up.

APRIL 11, 2014 7:28 P.M.

Jay wrote:

The Wells Fargo analyst lives in the fantasy land.

APRIL 11, 2014 10:05 P.M.

Share Price Dictates Perception wrote:

Right now, AAPL is in a transitional period. It's gotten to big to produce percent increases in key metrics to be considered a growth stock. At the same time, it's only been a year that it's started to act like a big cap value stock by buying back shares and declaring a dividend. Little doubt that AAPL will see $1000 a share at some point in the next year or two. The company prints money. It's still number one in terms of annual profits with Exxon close behind. Add free cash flow of tens of billions and AAPL is in complete control of its destiny long term.

The problem here is share price and investor myopia. People are just too short sighted to see the big picture. If one is going to judge AAPL, then wait until the end of this year when new products come out to make the judgment. I was reading today that AAPL was in talks to get health insurers to subsidize the iWatch. How genius is that if they can make it happen? Typical AAPL thinking outside the box. If insurers subsidize the iWatch it will be just like the model with the phone carriers. AAPL will be able to charge whatever they want and people will pay. Nobody even comes close to doing that kind of thinking. The same is true of sapphire which AAPL is investing in. Watch sapphire become the defacto standard for smart device screens in a few years. Just like touch ID and 64 bit chips will soon be standard.

Wall Street has been pumping junk for over a year now and left AAPL's stock languishing. But the game for the long term investor isn't a sprint. It's a marathon. I'd rather run that sprint with a company like AAPL than just about any other name out there.

APRIL 11, 2014 10:14 P.M.

luke wrote:

wow..so many analysts and commenters are so sure they know what apple should do..manard says apple has "a mindset toward high-end luxury goods with healthier margin, rather than lower end commodities" like thats a bad thing! why would apple want to dominate the low market where there is no profit and people don't use those cheap phones to buy anything else??? and the Iwatch should be used to spy on peoples habits so they can try to use that info to advertise? sounds more like google..lol
Apple is the most successful and profitable tech company in the world, and revenues are still growing every year..until that stops being the case, maybe everyone should keep there grand ideas to themselves..or better yet..start your own company and we will all tell you how to do it better...lol
and by the way..apple does sell a phone under 500..its the 4s..and even the 4 in some markets! and you can buy used iphones too..thats as low as apple needs to go..
and Hu Flung... I believe the line was..Customers want what THEY don't have.. not what we don't have..lol
so why is samsung now coming out with a 4" screen..? its because even they know that many people don't want a bigger phone! apple sold way more 4"phones than samsung sold 5" or bigger phones..hello

About Tech Trader Daily

Tech Trader Daily is a blog on technology investing written by Barron’s veteran Tiernan Ray. The blog provides news, analysis and original reporting on events important to investors in software, hardware, the Internet, telecommunications and related fields. Comments and tips can be sent to: techtraderdaily@barrons.com.